Corporate Governance

Executive Compensation, Business As Usual, and the Need for Comprehensive Reform

By J. Robert Brown

The NYT reports that financial institutions are preparing to announce bonuses and they are likely to be large (Banks Prepare for Bigger Bonuses, and Public's Wrath).  According to the article:

• The bank bonus season, that annual rite of big money and bigger egos, begins in earnest this week, and it looks as if it will be one of the largest and most controversial blowouts the industry has ever seen.

Moreover, these payments are not being made without awareness of the reaction that they will draw from the public. 

• Industry executives acknowledge that the numbers being tossed around — six-, seven- and even eight-figure sums for some chief executives and top producers — will probably stun the many Americans still hurting from the financial collapse and ensuing Great Recession.

What is going on here? 

There are several observations.  First, the paychecks approved by the government with respect to Fannie Mae and Freddie Mac (somewhere in the vicinity of $6 million) and those approved by the Pay Czar (at Citigroup, he approved pay packages worth $5 million or more for 6 employees) signal to the market that high pay is acceptable, even in these tough economic periods.

Second, individual financial institutions will in fact find themselves at a competitive disadvantage if everyone else pays high bonuses but they do not.  In other words, if the new report that BofA or Morgan Stanley paid low bonuses, they would deserve not accolades but criticism from shareholders once the outpouring of talent started. 

Third, this demonstrates the need for reform that is comprehensive.  So far, the only reforms to have been put in place are those that apply to financial institutions taking TARP money.  Once the funds are repaid, the limits disappear.  Thus, Goldman and BofA are free to pay whatever bonuses they want.  There are supposed to be legal limits on compensation but those limits are imposed under state (read Delaware) law.  The limits have been eviscerated, with the result that there are no effective legal limits on excutive compensation.  (This is discussed in greater detail in Returning Fairness to Executive Compensation).  

These high bonuses are predictable.  They show that the problems of excessive compensation cannot be solved by individual financial institutions.  Instead, there needs to be a comprehensive legal solution.  Right now, though, there is no meaningful solution on the horizon. 

Full post as published by The Race to the Bottom on January 10, 2010 (boomark / email).